Battling the Property Pirates

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More American companies these days are fighting in court to protect the intellectual-property rights of patents, trademarks, and copyrights. Indeed, roughly 2,700 patent lawsuits were filed in 2002, more than double the filings a decade ago, according to intellectual-property-management consulting firm General Patent Corp. And some companies are winning. Just ask Ebay Inc., which recently lost a $30 million verdict to MercExchange LLC over claims that the Internet auction firm infringed on MercExchange’s patents with its “buy it now” technology. AT&T, too, is suing Ebay and its subsidiary PayPal for patent infringement of technology related to credit-card transactions. Even when such cases are settled, they typically result in licensing arrangements between the two companies.

But when it comes to using the courts to defend company IP rights in developing countries, of course, the proposition is much dicier. For starters, even the most basic property protections are not always recognized. And when they are, legal disputes are often heavily colored by political influence. IP rights are especially vulnerable to such interference. That is why the collapse of the latest round of World Trade Organization (WTO) talks, last fall in Cancun, so disappointed those who believe that patent protection and the like are critical for sustainable economic growth.

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High on the agenda at Cancun, at least as far as the United States was concerned, were steps to enforce a 1994 agreement during the GATT Uruguay round of trade talks. The pact, known as the Trade-Related Aspects of Intellectual Property Rights (TRIPS) agreement, not only recognizes IP rights but also sets deadlines for enforcement. Yet the United States insists that many of those deadlines have passed without compliance.

Beaten to the Punch

Such an environment leaves a U.S. company in a tenuous position when it ventures abroad. Without the temporary monopoly that enforceable patents, trademarks, and copyrights provide, there’s nothing to prevent competitors from infringing on a company’s IP rights and undercutting its position in local markets. And that is happening to a worrying degree, in fact, in many emerging markets. A report earlier this year by the U.S. Trade Representative’s office estimated that piracy costs U.S. companies as much as $250 billion a year. Those doing business in China, Taiwan, and Hong Kong are very concerned, says Amy Xu, a Minneapolis-based attorney with Dorsey & Whitney, especially about the fate of “their top-line products.” DuPont, IBM, Kodak, Procter & Gamble, and 3M have all been aggressively filing patent applications with the Chinese patent office, she notes. As early as 2000, P&G had filed 516 applications, the most by any non-Chinese company except Japan’s Matsushita, according to a Website maintained by the Chinese patent office. At the time, IBM was seventh on the list, with 324. (More-recent data on these companies is not available.)

In much of the developed world, to be sure, patent protection just about matches that in the United States, yet important distinctions remain. Patents in Europe are granted on a first-come, first-served basis, for instance, while U.S. patents go to the company that proves it invented the technology. That difference leaves U.S. companies at a decided disadvantage if they are beaten to the punch by European competitors. Nevertheless, some American firms have managed to win at least a handful of patents in Europe. According to a database maintained by Thomson Corp.’s Delphion, Cisco Systems Inc. possesses seven German patents, for example, and an equal number of European patents that cover all 27 countries that belong to the European Patent Convention. Still, that’s a far cry from the 1,371 patents Cisco holds in the United States, according to the database.

Wide World of Standards

U.S. software firms find themselves in a particularly acute bind abroad. In contrast to the U.S. regime, foreign governments generally don’t grant patent protection to software innovations, because they consider the math logarithms involved part of the public domain. And while copyright protection is usually available, it goes only so far. By the lights of these governments, in other words, software copying doesn’t amount to piracy. No wonder an estimated 95 percent of the PCs in China are running pirated software, and that a copy of the next generation of Microsoft’s Windows operating system, code-named Longhorn, recently appeared on the Internet although the company is still some two years from releasing it.

Microsoft’s recent decision to liberalize its licensing agreements and even donate certain types of software reflects this predicament. The move may help Microsoft’s legal cause in Europe, where antitrust regulators are giving the company a much harder time over its marketing practices than the Bush Administration did. However, the new policy doesn’t apply to Windows, which accounts for the vast majority of the company’s revenue and profits.

U.S. companies in other industries at least have the option of aggressively defending their IP rights abroad, however limited their protection and recourse may be. And in doing so, they enter a universe of widely varying legal standards. Of course, much depends on how extensively a given country embraces market capitalism and free trade. While most of the TRIPS agreement’s provisions have yet to be implemented, the fact that IP rights remain on the WTO’s agenda reflects a grudging recognition by most countries that patents, trademarks, and copyrights underpin trade.

As a result, even such socialist systems as China’s offer some levels of both safeguards and remedies, say lawyers specializing in such cases. Despite perceptions to the contrary, “it’s not true that you can’t protect patents there,” says attorney Keith Nowak of the New York office of Dickstein Shapiro Morin & Oshinsky. But with Chinese legal disputes subject to myriad political considerations, and in any case likely to take years to resolve, Nowak concedes that a more-practical approach may be through various “business solutions.” He cites the case of a U.S. toy-company client, which he declines to name. It responded to Chinese importers’ U.S. trademark violations not by filing suit, but by acquiring a 50 percent stake in the Chinese manufacturer of the knockoffs. That way, the client assured itself of at least half the royalties in question.

Of course, such equity investments may not stop IP theft. General Motors is investigating whether a Chinese joint-venture partner had given a manufacturing design to another company in which it had an interest: it was the second time in the past year that GM may have been victimized in this fashion in China.

Still, U.S. companies have reason to hope that as markets become more interconnected, leverage may be gained from the IP protection prevailing in this country. Consider the case of Cisco and Huawei Technologies, a Chinese competitor in network routing products. Last January Cisco filed suit in a Texas federal district court, alleging Huawei violated IP rights that Cisco holds in the United States. “Until recently, Cisco never used its patents to protect its market share,” notes General Patent founder and CEO Alexander Poltorak.

Obviously, Cisco’s U.S. patents aren’t enforceable in China. But the company was able to pursue its federal-court case by naming two Huawei U.S. subsidiaries, FutureWei and Huawei America. Granted, it isn’t always easy to determine the parentage of Chinese companies operating in this country; attorney Stephen Kramarsky, a partner at Dewey, Pegno, and Kramarsky, in New York, goes so far as to say that “it’s almost impossible.” Cisco’s progress, though, was made easier because Huawei’s founder is a highly visible former Chinese Army officer. After obtaining a preliminary injunction against Huawei in federal court, Cisco decided on October 1 to suspend its suit for six months—until April 1—in return for Huawei’s agreement to alter its technology to honor Cisco’s patents. What’s more, the agreement applies worldwide. That’s significant, since Huawei has sought to undercut Cisco’s router business with cheaper, reverse-engineered versions in Europe, the United States, and Asia (see “Is Cisco Kidding” at the end of this article).

Attorneys and other experts say it is not unusual to have worldwide agreements based on U.S. patents, similar to the one signed by Cisco and Huawei. Such cases are hard to track, however, because the vast majority of IP lawsuits don’t go to trial, and the settlements are undisclosed. For what it’s worth, the Cisco-Huawei agreement—in its form as a six-month stay—calls for any changes Huawei makes to its technology to be assessed by an independent third party.

At this point, it’s safe to say that Cisco isn’t the only American company to have circled April 1 on its 2004 calendar, and to hope that Huawei’s response won’t be “April Fools!”

Ronald Fink is a deputy editor of CFO.

Is Cisco Kidding?

Just how big a threat Huawei Technologies poses to Cisco Systems Inc. is difficult to gauge. According to Gartner, Huawei’s routers are priced as low as $1,400, significantly less than comparable Cisco offerings. In both Europe and America, Cisco’s profit margins average around 70 percent, estimates Hasan Imam, an analyst for the merchant bank Thomas Weisel Partners, while Cisco’s margins in China and elsewhere in Asia range from about 50 percent to 60 percent. Because of these differences, Imam expects Cisco to pursue its agreement with Huawei far more aggressively in Europe and the United States.

While the Chinese company spends perhaps a couple of hundred million dollars a year on research and development—Cisco spends approximately $3 billion—Huawei’s revenues in 2002 reached $2.7 billion, a level that Imam describes as “critical mass,” with about a quarter of that coming from overseas. “Huawei has the potential to become a threat in Europe and North America,” at least at the low end of the networking market, says Imam. “That’s why Cisco finally woke up” and sued.

Some analysts say Cisco has little to fear. The threat from Huawei “is more of a perception” than a reality, says Gina Sockolow of Buckingham Research Group. “Anyone familiar with routers and the upgrades that are necessary would understand that,” she adds, noting that Huawei’s technology amounts to “a backward engineered solution without support.”

But Cisco isn’t taking any chances, automating and outsourcing its customer service to help maintain margins in the United States. Meanwhile, Huawei has been aggressively teaming with Western companies in joint ventures, so marketing and technical support of its products is likely to improve. Within six weeks of Cisco’s decision to suspend its suit, Huawei announced a new venture with Microsoft, and gained approval of another, with Cisco rival 3Com Corp.